According to a global survey of investment managers conducted by Towers Watson, the most important issues investment managers expect to face in 2013 are government intervention, global economic imbalances and sovereign debt defaults, with inflation being a significant concern in the next five years.

The Global Survey of Investment and Economic Expectations shows that guarded optimism has returned to this group of investment managers, witnessed by their view that institutional investors are expected to either modestly increase risk or keep their portfolio risk level the same in 2013. The survey, which includes responses from 169 investment managers (the majority having institutional assets under management above $5 billion and retail assets under management above $1 billion), indicates that a significant number of them still expect a sovereign debt default in the Eurozone and continuing weak fiscal situations in the U.S., the U.K. and Japan.

In contrast to last year, managers expect better equity returns in 2013 in most markets, with the exception of the U.S. and Australia, where equity return expectations are the lowest they have been since the survey started in 2008. In addition, managers anticipate equity returns to remain muted over the longer term, but indicate a preference toward the U.S. and China, and away from the Eurozone. They expect equity markets in 2013 to deliver returns of 7.0% in the U.S. (compared to 8.0% in 2012), 6.0% in the U.K. (5.0%), 7.0% in the Eurozone (6.0%), 6.0% in Australia (7.0%), 6.0% in Japan (5.0%) and 10% in China (7.8%).

The survey also shows that expected equity volatility for 2013 is in the 15% to 20% range for major economies, somewhat lower than previous years, but still elevated compared to longer-term averages. Most managers in the survey hold overall bullish views for the next five years on emerging market equities (83% vs. 75% in 2012), public equities (78% vs. 72%) and real estate (57% vs. 48%). For the same time horizon, the majority remains bearish overall on nominal government bonds (80% vs. 77% in 2012), money markets (47% vs. 43%), investment-grade bonds (47% vs. 29%) and inflation-indexed government bonds (47%, same as 2012).

“Volatile markets and heightened risk awareness continue to make asset allocation very challenging, as investors balance priorities such as long-term de-risking, short-term market opportunities, rebalancing and maintaining a strategic asset allocation mix. In terms of specific asset classes, we think that government bonds do not represent great value at the moment and that equities represent relatively better value. However, it is challenging to know how to respond when the goal for many funds is to reduce risk overall and diversify from existing equity holdings. As a result, many funds are buying fewer bonds than before, and those that are considering adding risk to their investment portfolios are most often diversifying into alternative assets rather than simply buying equities,” said Matt Stroud, head of strategy and portfolio construction at Towers Watson.

According to the study, real GDP growth expectations for 2013 continue a downward trend and range from just above 0% in the Eurozone (0% in 2012) to 7.5% in China (8.0%), followed by 2.5% in Australia (3.0%), 2.0% in the U.S. (2.0%), 1.0% in the U.K. (1.0%) and 0.9% in Japan (1.5%). With the exception of China, managers’ 10-year GDP growth forecasts are slightly above their one-year view but below historical trends. The survey shows that managers expect unemployment to remain a tough challenge for some Western economies, especially for the Eurozone countries implementing fiscal austerity measures. According to managers, expansionary monetary policies are expected to hold in 2013, with exceptionally low interest rates in some Western economies, but to gradually tighten in the years ahead. Inflation is viewed as a moderate near-term risk, with some very concerned about long-term inflation risk in both the U.S. and Europe.

Turning to 10-year government bond yields, for 2013, managers predict the continuation of a downward movement of yields to historic lows, reflecting persistent economic weakness and continued central bank asset purchases. Predicted yields on 10-year government bonds have fallen in every market since the 2011 survey, with the U.S. falling from 3.8% to 2.0%, mirrored by the U.K. (4.0% to 2.0%), the Eurozone (3.5% to 2.0%), Australia (6.0% to 3.3%), Japan (1.6% to 1.0%) and China (5.0% to 3.8%).

Other findings from the survey include:

For 2013, managers expect unemployment to be lower than in the recent past in the U.K. (7.7% vs. 8.5% in 2012) and the U.S. (7.5% vs. 8.5%), but higher in the Eurozone (11.5% vs. 10.6%);

The managers’ consensus is that crude oil is expected to rise at a fair pace, reaching $90 a barrel this year (they predicted $100 for 2012) and $100 a barrel in the next 10 years—significantly down from last year’s 10-year prediction of $120; and